Both Apple (AAPL) and Amazon.com (AMZN) recently hit all-time highs, and they’ve helped catapult the technology-heavy NASDAQ to a nearly 9 per cent gain for the year as of this writing. Apparently these stocks have built immunity to COVID-19 worries and the recession —at least for now.

Perhaps the innovators developing and adeptly harnessing new technologies should be booming—after all, these companies are transforming the way we live. Nevertheless, we at Morningstar aren’t willing to overpay for a stock, no matter how transformative a company may be. So today, we’re hunting for inexpensive innovators in the Morningstar Exponential Technologies Index.

As background, the Morningstar Exponential Technologies Index is designed to identify companies across sectors in the early stages of developing or using transformative technologies. It features 200 companies identified by Morningstar's equity research team as being positioned to experience meaningful economic benefits as a user or producer of promising technologies.

Morningstar has identified nine technology themes.

Big Data and Analytics: Capabilities with data sets too large and complex to manipulate or interrogate with standard methods or tools. Related subthemes include the "Internet of Things", machine learning, and artificial intelligence.

Networks and Computer Systems: Technology leaps ranging from hyperconnectivity and integrated systems, to service continuity and new software-defined architectures, will have a massive impact on the way people think of connecting applications and software with hardware.

Nanotechnology: The branch of technology that deals with dimensions and tolerances of less than 100 nanometers, especially the manipulation of individual atoms and molecules. We see a range of potential applications spanning medicine, computing, manufacturing, and travel.

Medicine and Neuroscience: Sciences, such as neurochemistry and experimental psychology, that deal with the nervous system and brain. Key advancements in unlocking the human genome have created an infrastructure of biomarkers, while paradigm shifts in biotechnology that can alter the immune system are radically changing the way we treat diseases.

Energy and Environmental Systems: This involves the exploration of renewable energy sources—including solar, wind, water, and batteries. As organizations set processes to help reduce environmental impacts and increase operating efficiency, new avenues for technological advancement across sectors will open up.

Robotics: The branch of technology that deals with the design, construction, operation, and application of robots. Advances in robotics, specifically when combined with other exponential technologies, have seemingly infinite potential applications, spanning technology, industrial, medical, and consumer-facing channels.

3D Printing: A process for making a physical object from a three-dimensional digital model. The emerging trend is ready for mainstream consumption and has ample potential to disrupt several industries, from industrial manufacturing and medicine, to consumer products and retail.

Bioinformatics: The science of collecting and analysing complex biological data. The "quantified sell" trend of acquiring data to quantify aspects of an individual's daily life has exponential potential to positively affect both the duration and quality of life.

Financial-Services Innovation: The search for and acknowledgement of emerging funding sources, platforms, currencies, and stored and transferred value. We not only think about opportunities to efficiently expand production but also the underlying currencies used (including cryptocurrencies), as well as structural shifts in technology and payment delivery methods.

Analysts score companies within those themes on a scale of 0 (no or little exposure to the theme) to 2 (significant exposure), relying on models to project growth over five, 10, and 20 years. We've isolated the 10 highest-scoring companies from the index that our analysts cover and are undervalued by our metrics today. Here’s our analysts’ business outlooks for each of those companies, as well as what themes each has exposure to.

Bristol-Myers Squibb (BMY)

Morningstar Rating (as of 6/18/20): 4 stars
Theme exposure: Big Data & Analytics, Nanotechnology, Medicine & Neuroscience, Bioinformatics

“Adept at partnerships and acquisitions, Bristol-Myers Squibb has built a strong portfolio of drugs and a robust pipeline. This strategy is seen with its recent large acquisition of Celgene, which netted the firm an excellent pipeline and a strong entrenchment in blood cancer. We believe the strong overall pipeline helps support its wide moat and steady growth potential.
Bristol has created a strong pipeline and brought in partners to share the development costs and diversify the risks of clinical and regulatory failure. We believe the cardiovascular partnership with Pfizer represents one of the most important partnerships, managing the blockbuster potential of Eliquis in atrial fibrillation. While Bristol discovered the drug internally, we like its strategic partnering decisions, as the moves reduce risks and lower development and marketing costs.

Within the pipeline, Bristol's astute acquisition of Medarex helps secure Bristol's strong first-mover advantage in cancer immunotherapy, which should yield several major blockbuster compounds. Bristol's PD-1 cancer drug Opdivo holds the potential to revolutionize cancer treatment and should drive multi-billion-dollar sales annually based on solid efficacy, combination potential with other drugs and strong pricing power. However, competition from Merck's Keytruda will likely limit Bristol's Opdivo in some segments of the market, including lung cancer.

Bristol is aggressively repositioning itself to expand through challenging patent losses. The company has shed its diabetes business, medical imaging group, wound-care division, and nutritional business in an effort to focus on the high-margin specialty drug group. The recent move to acquire Celgene moves Bristol significantly further into the specialty pharmaceutical segment of the market. Celgene's drugs largely target cancer, which tends to be an area with strong drug pricing power, which should help Bristol maintain its drug pricing ability in a time when both governments and private payers are pushing back on drug costs.”
Damien Conover, director

Intel (INTC)

Morningstar Rating (as of 6/18/20): 4 stars
Theme exposure: Big Data & Analytics, Nanotechnology, Networks & Computer Systems, Robotics

“Intel is the leader in the integrated design and manufacturing of microprocessors found in PCs and servers. With the rise in interconnectivity of devices, Intel strives to provide the most powerful and energy-efficient silicon solution to any product "smart and connected." The data centres used to facilitate the information stored, analysed, and accessed by various front-end devices are mostly run with Intel server chips.

Intel differentiates itself first and foremost via the continued execution of Moore's law, which predicts transistor density on integrated circuits will double about every two years, meaning subsequent chips have substantial power, cost, and size improvements. This scaling advantage is perpetuated through higher-than-peer-average R&D and capital expenditure budget that allows it to control the entire design and manufacturing process in an industry where the majority of competition focuses on only one phase. While the firm has had issues with its 10-nanometer process in recent years, we expect the firm to get back on track with its 7-nanometer process in 2021 with the help of EUV lithography.

As cloud computing continues to garner significant investment, Intel's data centre group will be an indirect beneficiary. Mobile devices have become the preferred device to perform computing tasks and access data via cloud infrastructures that require considerable server build-outs. This development has provided strong tailwinds for Intel's lucrative server processor business. We believe the Altera and other AI-related acquisitions will help Intel maintain its recent growth trajectory in the space, as customers increasingly seek out customized server solutions.

The proliferation of mobile devices has come at the expense of the mature PC market, Intel's historic stronghold, with ARM and its cohorts joining AMD as chief rivals. The rise of artificial intelligence has also unleashed a new competitor in Nvidia for specialized chips to accelerate AI-related workloads. Consequently, Intel has built a broad accelerator portfolio via the acquisition of Altera for FPGAs, Mobileye for computer vision chips used in cars, Nervana neural processors, and Movidius VPUs.” (Abhinav Davuluri, sector strategist)

Alibaba Group Holding ADR (BABA)

Morningstar Rating (as of 6/18/20): 4 stars
Theme exposure: Big Data & Analytics, Networks & Computer Systems, Financial Services Innovation

“Alibaba is a big data-centric conglomerate, with transaction data from its marketplaces, financial services, and logistics businesses allowing it to move into cloud computing, media/entertainment, and online-to-offline services. We think a strong network effect allows leading e-commerce players to extend into other growth avenues, and nowhere is that more evident than Alibaba.

Alibaba’s Internet services affect the vast majority of Chinese Internet users, including an 83 per cent penetration rate for the Taobao/Tmall e-commerce marketplaces as of December 2019, based on Chinese Internet users of over 855 million as of June 2019 as per CNNIC. This provides Alibaba with an unparalleled source of data that it can use to help merchants and consumer brands develop personalized mobile marketing and content strategies to expand their target audiences, increase click-through rates and physical store transactions, and bolster return on investment. Alibaba's marketplace monetization rates have generally been on an upward trend despite recent macro uncertainty, indicating that sellers are increasingly engaging with Alibaba's marketplaces and payment solutions, although COVID-19 and more competition will put pressure on monetization in the near to medium term. Gross merchandise volume per active user was CNY 730 for the year ended March 19 for Alibaba, higher than CNY 143 in 2019 for Pinduoduo and CNY 362 in 2019 for JD.

While we view Taobao/Tmall marketplaces as Alibaba's core cash flow drivers, we also believe AliCloud, digitalization for businesses, and globalization offer long-term potential. While AliCloud will remain in investment mode near-term, we believe accelerating revenue per user suggest a migration to value-added content delivery and database services that can drive segment margins higher over time. On globalization, third-party merchants are successfully reaching Lazada's users across Southeast Asia, something that should continue as the company rolls out incremental personalized mobile marketing and content opportunities. While early, we share management’s views about Ele.me and digital entertainment being incremental monetization opportunities of Alibaba’s user base.”
Chelsey Tam, analyst

HP (HPQ)

Morningstar Rating (as of 6/18/20): 4 stars
Theme exposure: Big Data & Analytics, Nanotechnology, Networks & Computer Systems, 3D Printing

“Although we expect HP to remain a leader in the personal computer and printing markets, we opine that difficult long-term business environments should temper sustainable growth opportunities. Industry shifts toward using mobile devices as computer supplements or replacements and fewer printing tasks being performed for economic and environmental reasons may create headwinds for HP. We believe that HP's growth initiatives will expand its market share within the PC and printing industries as consolidation occurs, but we expect cost competitiveness among the remaining vendors to limit potential upside.

We believe personal computer purchases will contract as more households primarily use smartphones for computing tasks and as cloud-based software upgrades can delay the impetus to upgrade computer hardware. HP's personal systems business, containing notebooks, desktops, and workstations, yields a narrow operating margin that we do not foresee expanding. The company's growth focus areas of device-as-a-service, or DaaS, and expanding its gaming and premium product offerings should help stem losses from its core expertise of selling basic computer systems. Contractual service offerings like HP's DaaS are alluring to businesses since IT teams can offload hardware management, receive analytics to proactively mitigate computer issues, and pay monthly instead of facing unpredictable large capital expenditures.

HP's contractual managed print services, in additional to focusing on graphics, A3, and 3D printers are moves in the correct direction, but the overarching trend of lower printing demand should stymie revenue growth within printing, in our view. The company is innovating in a mature market, but we believe competitors can mimic HP's successes or cause price disruption. HP's scale may enable success within the 3D printing market; even though HP is late entrant, its movement into printing metals could cause customer adoption. Our largest concern with the printing market is the overall trend of screen reading replacing printed pages, and we do not believe HP's initiatives can offset the macro trend.”
Mark Cash, analyst

Merck (MRK)

Morningstar Rating (as of 6/18/20): 4 stars
Theme exposure: Big Data & Analytics, Nanotechnology, Medicine & Neuroscience, Bioinformatics

“Merck's combination of a wide line-up of high-margin drugs and a pipeline of new drugs should ensure strong returns on invested capital over the long term. Further, Merck is through the worst of its patent cliff, which should remove the heightened generic competition the company has experienced over the past years. And after several years of only moderate research and development productivity, Merck's drug development strategy is yielding important new drugs.

Merck's new products have mitigated the generic competition, offsetting the recent major patent losses. In particular, Keytruda for cancer represents a key blockbuster with multi-billion-dollar potential: It holds a first-mover advantage in one of the largest cancer indications of non-small cell lung cancer. Also, we expect new cancer drug combinations will further propel Merck's overall drug sales. However, we expect intense competition in the cancer market with several competitive drugs likely to report important clinical data between 2019 and 2020. Other headwinds include generic competition, notably to cardiovascular drugs Zetia and Vytorin, which is likely to create a drag on overall growth.

After several years of mixed results, Merck's R&D productivity is improving as the company shifts more toward areas of unmet medical need. Owing to side effects or lack of compelling efficacy, Merck experienced major setbacks with cardiovascular disease drugs anacetrapib, Tredaptive, Rolofylline, and TRA along with Telcagepant for migraines. Safety questions ended the development of osteoporosis drug odanacatib. Despite these setbacks, Merck has some solid successes, including a successful launch for its PD-1 drug Keytruda in oncology. Following on this success, Merck is shifting its focus toward areas of unmet medical need in specialty-care areas, and Keytruda is leading this new direction. We expect Keytruda's leadership in non-small cell lung cancer will be a key driver of growth for the company over the next several years.”
Damien Conover, director

Zimmer Biomet (ZBH)

Morningstar Rating (as of 6/18/20): 4 stars
Theme exposure: Big Data & Analytics, Robotics, 3D Printing

“Zimmer, the leader in hip and knee reconstruction, enjoys the fruits of a wide economic moat. With the addition of smaller competitor Biomet, Zimmer is the undisputed king of large joint reconstruction, by far. We expect favourable demographics, which include aging baby boomers and rising obesity, to fuel solid demand for large-joint replacement that should offset price declines. However, Zimmer has been plagued with pitfalls since late 2016, including integration issues, supply and inventory challenges, and quality concerns that have caught the attention of the U.S. Food and Drug Administration. But new management has tackled these issues, and the firm is poised to ramp up its growth.

Zimmer has benefited from close relationships with orthopaedic surgeons who make the brand choice. High switching costs and high-touch service keep the surgeons closely tied to their primary vendor, and the surgeons bring in enough profitable procedures to keep hospital administrators at bay. This close relationship and vendor loyalty also explain why market share shifts in orthopaedic implants are glacial, at best. As long as Zimmer can launch comparable technology within a few years of its rivals, it can remain in a strong competitive position. Nevertheless, we think surgeon influence will inevitably erode, as the practice of medicine changes in response to healthcare reform. Over the long term, it will be more difficult for surgeons to run private practices profitably, and more of them will be open to employment at hospitals.

We think the growing emphasis by payers and hospitals on comparative effectiveness and cost-effectiveness will make conditions tougher for Zimmer and its rivals. By its nature, orthopaedic innovation tends to be evolutionary rather than revolutionary. It is also less common for orthopaedic innovation to tap into untreated patient pools with unmet needs, which is a strategy cardiac device makers have pursued successfully. The difficulty and ethical issues surrounding randomized controlled trials for orthopaedics also weakens Zimmer's position when pressing for premium pricing. We think achieving meaningful innovation in orthopaedic implants will be challenging.”
Debbie Wang, senior analyst

Baidu.com ADR (BIDU)

Morningstar Rating (as of 6/18/20): 4 stars
Theme exposure: Big Data & Analytics, Nanotechnology, Network & Computer Systems, Financial Services Innovation

“Baidu has the urgency to strengthen its mobile business because it has not developed another industry-leading business other than its mobile search app for years. Baidu’s share of mobile time spend reduced to 6.9 per cent in March 2019 from 7.3 per cent year over year. Baidu positions its flagship Baidu app (173 million daily average users in March 2019) as a "super" app that can serve a wide range of users' needs, such as reading, watching videos, shopping, transportation tickets, food services, and so on, but we believe the app is less of a super app compared with Tencent’s Wechat (1.1 billion monthly average users). It has copied the strategies of its peers by launching a mini program (181 million MAU in March 2019) and short video apps (sevenfold year over year increase to 98 million MAU in March 2019 as per Questmobile).

We have not factored in the meaningful commercialisation of Baidu’s AI-based services, such as voice assistant platform DuerOS, autonomous driving platform Apollo and artificial intelligence cloud services. Search is driven by an artificial intelligence-powered algorithm, giving Baidu a good foundation in this segment. Baidu is also one of the largest and earliest companies to start AI investments in China. Currently, Baidu uses AI to recommend feeds to the app’s users to generate advertising revenue.

IQiyi, Baidu’s online video platform, has been a key growth driver stemming from increasing willingness to pay for premium content in China and continuous advertising demand on iQiyi. It accounted for 29 per cent of Baidu’s revenue in the first quarter of 2019.
In the near term, Baidu will invest heavily in its mobile business in terms of sales and marketing, and traffic acquisition. While meaningful monetization is uncertain, we expect Baidu to increase or maintain its research and development expenditure, which is at 17 per cent of sales in the first quarter of 2019. To fend off major competitor Tencent Video, iQiyi needs to continue to invest in premium content. Therefore, we expect Baidu’s margins to be under pressure in the near term.”
Chelsey Tam, analyst

Albermarle (ALB)

Morningstar Rating (as of 6/18/20): 4 stars
Theme exposure: Energy & Environmental Systems

“Albemarle is the world's largest lithium producer, which generates roughly half of total profits. It produces lithium through its own salt brine assets in Chile and two joint venture interests in Australian mines, Talison and Wodgina. Albemarle's Chilean operation is among the world's lowest-cost sources of lithium. Talison is one of the best spodumene resources in the world, which allows Albemarle to be one of the lowest-cost lithium hydroxide producers as spodumene can be converted directly into hydroxide.

As electric vehicle adoption increases, we expect high-double-digit annual growth in global lithium demand. In response, Albemarle plans to expand its lithium production capacity from roughly 85,000 metric tons in 2019 to 155,000 metric tons by the end of 2021. This includes the recently closed purchase of a 60 per cent interest in the Wodgina spodumene operation from Mineral Resources. Mineral Resources retains the other 40 per cent interest and the two operate a joint venture. The joint venture will begin producing spodumene (lithium hard rock concentrate) and one 50,000-metric-ton lithium hydroxide plant in Australia that will use Wodgina spodumene as its feedstock. We expect Albemarle to continue investing in increasing its lithium capacity after 2021. In our view, this will likely occur through either the acquisition of spodumene conversion assets, such as the Xinyu acquisition in 2017 or through brownfield capacity expansions in China and Australia.

Albemarle is the world's second-largest producer of bromine, a chemical used primarily in flame retardants for electronics. Bromine prices have begun to rise as increased demand for use in servers and automobile electronics is offset by a decline in demand from TVs, desktops, and laptops as well as lower demand for bromine used in oilfield completion fluids. Over the long term, we expect Albemarle to generate healthy bromine profits due to its low-cost position in the Dead Sea.

Albemarle is also a top producer of catalysts used in oil refining and petrochemical production. These chemicals are highly tailored to specific refineries and most need to be constantly replaced, giving the company a steady cash flow stream.”
Seth Goldstein, analyst

General Electric (GE)

Morningstar Rating (as of 6/18/20): 4 stars
Theme exposure: Big Data & Analytics, Nanotechnology, Network & Computer Systems, Energy & Environmental Systems, Medicine & Nanoscience, Robotics, 3D Printing, Bioinformatics

“Our GE thesis remains an all-out bet on industry vet Larry Culp. We believe he is the best industry executive to lead the long-term turnaround of GE. We credit Culp with the astute decision to sell GE Biopharma for $21.4 billion at greater than our assessed value, as well as his decision to methodically sell off over 63 per cent of GE's interest in Baker Hughes. Culp's decision to sell-off Biopharma and his GE Healthcare sales audible walked the appropriate balance between aggressively deleveraging the balance sheet, while retaining a valuable, strong cash flow-generating business of critical strategic importance.

Despite the rapid degradation in the commercial aerospace market, which we believe will translate to a delayed return of sales for a period of three years by year-end 2020, we still think GE Aviation's long-term fundamental secular drivers, including middle-income class growth and urbanization trends in developing nations, remain in place. We believe that Culp and his team can rapidly work to improve the segment's decremental margins to the mid-20s through a combination of aggressive cost-out and restructuring initiatives, including furloughs, curtailing discretionary spending, and a shift in commercial aerospace capacity to GE's strong military order book, among other initiatives. Working capital management, particularly in inventory levels, which are within Culp's lean culture sweet spot, should somewhat stem what we think will be modest free cash flow burn in full-year 2020.

Additionally, we think positive secular trends in GE Healthcare include an aging population and greater access to care. Despite the deflationary nature of the business, we think GE's digital initiatives can improve its mix and drive additional sales and margin growth. Finally, we think interest rate headwinds will pose an unfortunate headwind in both its pension and insurance obligations. Nevertheless, key to our long-term thesis is our view that GE should return to a high-single-digit free cash flow yield in the out years of our model as the remaining "inheritance taxes" from Alstom deal subside, which we believe will translate to a positive and appreciable inflection in free cash flow.” (Josh Aguilar, analyst)

Medtronic PLC (MDT)

Morningstar Rating (as of 6/18/20): 4 stars
Theme exposure: Big Data & Analytics, Medicine & Nanoscience, Robotics, Bioinformatics

“Medtronic's standing as the largest pure-play medical device maker remains a force to be reckoned with in the med-tech landscape. Pairing Medtronic's diversified product portfolio aimed at a wide range of chronic diseases with its expansive selection of products for acute care in hospitals has bolstered Medtronic's position as a key partner for its hospital customers.

Medtronic has historically focused on innovation, designing and manufacturing devices to address cardiac care, neurological and spinal conditions, and diabetes. All along, the firm has remained focused on its fundamental strategy of innovation. It is often first to market with new products and has invested heavily in internal research and development efforts as well as acquiring emerging technologies. However, in the postreform healthcare world where there are higher hurdles for securing reimbursement for next-generation technology, Medtronic has slightly shifted its strategy to focus on partnering more closely with its hospital clients by offering greater breadth of products and services to help hospitals operate more efficiently. By partnering more closely and integrating itself into more hospital operations, Medtronic is well positioned to take advantage of more business opportunities in the value-based reimbursement environment, in our view. In particular, Medtronic has been pioneering risk-based contracting around some of its cardiac and diabetes products, which we think is attractive to hospital clients and payers alike.

We have always appreciated Medtronic's diverse portfolio, where certain waning product lines would be offset by growth in other categories. The addition of devices and consumables used in the surgical suite should further stabilize potential speed bumps in individual product lines. Medtronic continues to focus on penetrating emerging markets, especially China. We estimate Medtronic generated nearly $2 billion in Chinese sales in fiscal 2019. Medtronic's broad portfolio of products fits well with the firm's earlier purchase of Kanghui Holdings, which provides the firm with an established network of native distributors that can reach thousands of hospitals in China.” (Debbie Wang, senior analyst)

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